Excuse me for the very long and somewhat rambling question, but I had to make sure I had every detail covered.
So I've been reading much on options, and I have been trying to wrap my head around the many different types of options strategies. One such strategy that I've been trying to understand clearly is the covered call. Please excuse my over-explanation, but it is important I understand all of this thoroughly and correctly.
An in-the-money call will cost the the intrinsic value plus the time value. So, if, for example, I owned 100 shares of a stock that I bought at $10 each, and I sold and in-the-money call option with a very low (and very deep in-the-money) strike price, I'm basically selling my shares plus profiting from the time value automatically, correct?
Let's say for the example, I sell one call option with a strike price of $2 when the stock is at $10. The profit from the option will be $8 (in intrinsic value) plus whatever time value is on there (let's say, for this example, it is $0.25, which seems like a fair price for an option that expires in a couple months). When the option gets exercised (either by assignment or when it expires), I will have made a total profit of $25 on the entire trade (($2 X 100) + ($8.25 X 100) - ($10 X 100)).
Assuming all this is true (which, of course, I am not sure it is), then couldn't one just quickly buy 100 shares of a stock, and sell the call option for an almost certain, albeit small, profit? I mean, there is still the risk of stock price falling below $2, but that risk seems so small that it seems like a sure thing. Even if you take out the cost of commissions (which, judging by your broker, could be around $10), you are still in a very good position to make a profit.
Perhaps I am over simplifying everything, not judging the risk appropriately, not taking in account some other fee I am unaware of, or something else, but this trade seems very sound. The chances of the stock actually dropping below $2 during the life of the option is so low, and I guess this is why the profit is so low. But if this strategy was multiplied by, say, 100 times the amount of contacts, then the profit would be $2,500 (minus commissions).
And also, if the stock were to start falling unpredictable towards $2 a share, couldn't you just sell the option and the shares before it actually hit $2 per share? Although your profits from the option is going to be lower than if you would have let it expire, it could still be profitable because as the stock fell in price, the option would fall accordingly, right? Or, at the worst, it could limit the losses.
Although the profit seems very small, the risk seems to be smaller. Am I missing something here? Cause having a stock fall more than 80% during the life of an option just doesn't seem likely enough to deter the small profits that could add up. If you do sell a call option that is in-the-money, isn't it going to at least net you a small profit every time?
An example of all this is The Boeing Company (BA). It is currently at $70 a share, and it is selling call options that expire in November with a strike price of $40 for $31.35. By selling that contract (and assuming you had 100 shares of BA bought at $70), you are guaranteed a profit of $71.35 per share. Right? And I know the profit is limited to this, which is fairly low (seeing how the stock can easily move above $71.35), but the chances of the stock's price moving below $40 dollars (or, to be exact, $38.65, an almost 50% loss ) is very low and could easily be seen a mile away. Right? Adding in costs from a cheaper broker (I'm getting the examples from OptionsHouse), that would be ~$8 to buy and sell the shares, and ~$9 for the option, and $7,000 for the shares, rounding up to a cost of $7,020. Since you would make a profit of $7,135, your net proceeds would be $115. And although this is only a gain of ~1.9% for about a 4 month investment, the risk was so small that it seems worth it.
Now, I haven't started trading options yet, for I am still trying to learn as much as I can, but I just wanted to know if what I am saying is right. Although I would probably not trade for such small gains, and the strategy I presented seems impractical, I only need to know if my theory is right.
So I've been reading much on options, and I have been trying to wrap my head around the many different types of options strategies. One such strategy that I've been trying to understand clearly is the covered call. Please excuse my over-explanation, but it is important I understand all of this thoroughly and correctly.
An in-the-money call will cost the the intrinsic value plus the time value. So, if, for example, I owned 100 shares of a stock that I bought at $10 each, and I sold and in-the-money call option with a very low (and very deep in-the-money) strike price, I'm basically selling my shares plus profiting from the time value automatically, correct?
Let's say for the example, I sell one call option with a strike price of $2 when the stock is at $10. The profit from the option will be $8 (in intrinsic value) plus whatever time value is on there (let's say, for this example, it is $0.25, which seems like a fair price for an option that expires in a couple months). When the option gets exercised (either by assignment or when it expires), I will have made a total profit of $25 on the entire trade (($2 X 100) + ($8.25 X 100) - ($10 X 100)).
Assuming all this is true (which, of course, I am not sure it is), then couldn't one just quickly buy 100 shares of a stock, and sell the call option for an almost certain, albeit small, profit? I mean, there is still the risk of stock price falling below $2, but that risk seems so small that it seems like a sure thing. Even if you take out the cost of commissions (which, judging by your broker, could be around $10), you are still in a very good position to make a profit.
Perhaps I am over simplifying everything, not judging the risk appropriately, not taking in account some other fee I am unaware of, or something else, but this trade seems very sound. The chances of the stock actually dropping below $2 during the life of the option is so low, and I guess this is why the profit is so low. But if this strategy was multiplied by, say, 100 times the amount of contacts, then the profit would be $2,500 (minus commissions).
And also, if the stock were to start falling unpredictable towards $2 a share, couldn't you just sell the option and the shares before it actually hit $2 per share? Although your profits from the option is going to be lower than if you would have let it expire, it could still be profitable because as the stock fell in price, the option would fall accordingly, right? Or, at the worst, it could limit the losses.
Although the profit seems very small, the risk seems to be smaller. Am I missing something here? Cause having a stock fall more than 80% during the life of an option just doesn't seem likely enough to deter the small profits that could add up. If you do sell a call option that is in-the-money, isn't it going to at least net you a small profit every time?
An example of all this is The Boeing Company (BA). It is currently at $70 a share, and it is selling call options that expire in November with a strike price of $40 for $31.35. By selling that contract (and assuming you had 100 shares of BA bought at $70), you are guaranteed a profit of $71.35 per share. Right? And I know the profit is limited to this, which is fairly low (seeing how the stock can easily move above $71.35), but the chances of the stock's price moving below $40 dollars (or, to be exact, $38.65, an almost 50% loss ) is very low and could easily be seen a mile away. Right? Adding in costs from a cheaper broker (I'm getting the examples from OptionsHouse), that would be ~$8 to buy and sell the shares, and ~$9 for the option, and $7,000 for the shares, rounding up to a cost of $7,020. Since you would make a profit of $7,135, your net proceeds would be $115. And although this is only a gain of ~1.9% for about a 4 month investment, the risk was so small that it seems worth it.
Now, I haven't started trading options yet, for I am still trying to learn as much as I can, but I just wanted to know if what I am saying is right. Although I would probably not trade for such small gains, and the strategy I presented seems impractical, I only need to know if my theory is right.
